When bankers at UBS, the Swiss investment bank, recently invented a commodity investment scheme for devout Muslims, they were eager to start marketing their brainchild.
But first they took a step that once would have been almost unimaginable in the banking world: they asked American lawyers to file a patent to stop their idea being pinched.
“People haven’t traditionally recognised the value in patenting these types of products,” says Peter Ghavami, global head of commodities at UBS. “But these days the conventional wisdom is being challenged. We believe this patent should give us some protection.”
Bankers have historically been highly aggressive in protecting their turf – and profits – but surprisingly bad at stopping rivals from copying ideas. While patents are a vital tool for, say, pharmaceutical companies, their use has not been widespread in finance.
As a result, whenever a bank produces a startling innovation, it is quickly copied elsewhere. When ABN Amro, for example, came up with a product called a “constant proportion debt obligation” last summer, other banks replicated the scheme within days.
In recent years, however, attitudes to intellectual property have undergone a subtle shift, as banks and other financial companies have become much more active in filing patents, particularly in the US.
In Europe, financial services or so-called “business method” patents are rare because they are granted only where they can be shown to have solved a specific technical problem, usually defined as non-financial or non-economic. And, say lawyers, the few financial services patents that do exist are seldom enforced in the courts.
But in the US, a 1998 ruling in a case involving State Street Bank made clear that business processes could be patented. A flood of applications followed and these are now feeding through into issued patents.
“This was the waving of the chequered flag. At that point, financial services companies started looking at every innovation to see if it was patentable and started hiring lawyers to build patent portfolios,” says one intellectual property lawyer at a big investment bank.
The number of US patents issued for financial services soared in 2006, rising threefold to 238. Many of these patents were issued to large US financial companies such as Citigroup, JPMorgan and Goldman Sachs. General Electric’s finance arms headed the field with 11.
Edward Filardi, an intellectual property lawyer at Skadden, Arps, says the growth in patent applications for financial services is far from over. A reason for this is that
patents not only protect intellectual property, they can also be turned against companies (see below).
“Patent applications are snowballing and it’s going to continue,” Mr Filardi says. “Large financial institutions don’t want to be in a position where a small company or individual can exert undue influence on their business.”
Citigroup is one of more than 50 US banks being sued over patents that cover remote cheque image processing. Some banks, including JPMorgan, have settled with the company that was founded by the patent owner, Claudio Ballard, but most are fighting.
This is one of very few overt legal battles in this area, but others could soon bubble over.
Eurex, the European exchange, plans to launch a credit futures contract later this spring. But the intellectual property for a technique that calculates a key component of this type of contract – known as a credit fixing – has been claimed by Creditex. A US-based company, Creditex is determined not to let rivals use it. This has forced Eurex to turn to alternative techniques, complicating its plans.
Banks now view intellectual property as an important operational risk, say lawyers. Investment banks and other financial services companies are actively building portfolios of business process patents.
Some in the financial world view this with dismay. Satyajit Das, a former
trader who now works as a consultant, argues that the rise of financial patents could crush innovation.
“Just imagine if something such as Black-Scholes had been patented – it would never have circulated so widely, and [created] the whole options market,” he says. “Patents will just end up enriching the lawyers.”
Lawyers – perhaps unsurprisingly – dispute this. “If you have patents in industry, why shouldn’t you protect intellectual property in finance too?” asks a lawyer at a US bank.
Other trends are also raising the pressure to protect intellectual property rights.
One is the fact that the spread of technology has made it easier than ever for ideas to travel across the globe. In the 1970s it typically took 10 to 15 years for products to become ubiquitous in the market place. Now innovations diffuse “in less than five years”, according to Mercer Oliver Wyman, the consultant.
At the same time, financial innovation is becoming more complex and thus more amenable to protection from patents. One way that banks are trying to gain a competitive edge on each other is in the use of mathematical algorithms. Another is in trading systems or software.
The Chicago Mercantile Exchange is now so determined to protect its intellectual property it has a full-time patent attorney on staff. “We have lodged several patents,” says James Krause, chief information officer.
Glenn Manchester, head of Thunderhead, a small British company that develops software for credit derivatives trades, echoes the sentiment. “We definitely want to protect our intellectual property . . . with patents,” he says.
However, the efficacy of such techniques is relatively untested, not least because defining what is unique in financial innovation can be extremely hard.
“If you look at chemical compounds, it is clear what they are – but if you look
at financial ideas, they tend to be amorphous,” says
In a world where financial innovation can be spectacularly profitable – and where banks are desperate to
retain control of the output of their nimble-footed staff – nobody expects the patent trend to end soon.
As one head of credit derivative product development at a major investment bank explains: “Filing a patent is a very low-cost option to protect something that you have spent time and money to develop, and which could prove very profitable in the future.”
The question, he says, is not so much why patent, as why not?
“We feel pretty confident that the patent application will be successful,” says Mr Ghavami of the UBS innovation that allows Islamic investors to gain exposure to commodities without contravening the Koran. “[We hope] that it will offer protection against imitation.”
Additional reporting by David Wighton
Beware the ‘patent trolls’ of finance
The growth of patenting in the financial services industry is reminiscent of the nuclear arms race: patents are very seldom used but provide protection from the patents of others.
“It’s important to have a robust patent arsenal because your competitors will,” says one intellectual property lawyer at a big investment bank.
However, the world of financial patents also has its “rogue states”. Patents for financial business methods have been awarded to small companies and individuals, some of whom operate as so-called “patent trolls”.
These individuals try to obtain patents with the sole intention of holding financial services companies to ransom for business methods that are sometimes widely accepted.
In the pharmaceutical industry, those filing patents would typically support their application by referring to relevant academic research. Yet research by Josh Lerner, a professor at Harvard Business School, shows that in financial patents, “these works are far less often cited than in patents in other academically related areas, such as biotechnology.”
An example is Vergil Daughtery, a graduate of Georgia Tech management school, who has received four patents for the pricing of “expirationless options”. This was “despite the fact that perpetual options had been extensively studied in the finance literature since the 1960s,” says Prof Lerner.
In June, the company to which Mr Daughtery licensed the patents filed a suit against the Philadelphia Stock Exchange for infringement.
Prof Lerner’s research shows that the financial services sector has been especially vulnerable to such suits: between 1976 and 2003, financial patents were 27 times more likely to come to court than non-financial ones, and litigated patents were disproportionately those awarded to individuals.
Part of the problem is that the US patent office is painfully under-resourced, explains Edward Filardi, partner at Skadden, Arps, a US law firm. “The patent office has very limited resources in terms of searching publications and websites for existing business methods. This is a particular problem in an area where there are a limited number of existing patents.”
Prof Lerner adds that the patent system is hamstrung by the “rapid reviews” given to applications in emerging areas by “underpaid, inexperienced patent examiners”. The litigation system also presumes that granted patents are valid, while relying on juries that are often “ill-suited for resolving these technical disputes”, he says.